Tuesday, September 26, 2023
Author: Stuart Lucas
When I used to run trading desks for investment banks, our mission was a big one but a simple one: become the ‘house’ for any given security. The balancing act required to achieve this meant we were always mindful to be as big a factor of the liquidity available, but never become ‘the liquidity’. By that, I mean, we worked hard to make sure we weren’t such a dominant source of liquidity as that sale would negatively impact price.
It’s always good to remember that any market-maker, jobber, or specialist sits at the ‘pointy bit’ of an inverted pyramid. Simply put, the capacity of all trading capital that dealers and intermediaries are prepared to commit, will always be but a small fraction of the total available. In down periods, much is often on the sidelines, awaiting risk appetite to return. This was always thus throughout my career, further post-2008, with the majority of the world’s ‘risk capital’ sucked out of the system.
A lot of the chatter around private markets —and Private Equity in particular— at the moment seems to have forgotten this, with numerous talking heads in the sector sounding the alarm over a supposed catastrophic lack of liquidity.
Let's look more broadly at what’s going on.
There’s no doubt about it, this is a tough environment to take risks in. Many investors, whatever their level, if not fully invested, are fearful of how and when to use their ‘dry powder’. Those that are fully invested, long for an exit, or five! The pace of company growth has slowed, but cash is required to reignite activity. You see the log-jam.
Fortunately, solutions are often borne from necessity and create opportunities that become a norm and benefit others down the food chain. When I arrived on Wall Street in the 1980s, the leveraged buyouts (LBOs) explosion was the catalyst. Back then, it’s worth noting, interest rates were around 12% in the UK and US and this didn’t put people off. Acquirers just had to be sure they were buying a good business and their holding period would not be too long. The taking private of large corporates meant that investment funds had to reinvest their cash accordingly.
We’re seeing something similar happening now, with a plate shift at the top end of PE. Permira, for example, has recently agreed to buy UK pharma services firm Ergomed, taking it private for £703 million. While the Forge Private Market Index (a benchmark for actively traded private companies) has turned positive over the last three months. These are subtle signs, but potential leading indicators. Over time, an accumulation of such factors trickles down, recycling capital back into the market and bolstering sentiment. The flapping of the butterfly’s wings.
In the dot-com, dot-bomb period 23 years ago, many funds were launched with a 10 year maturity and a seven year average life. Such was the pace and vibrancy that many funds invested, held, then sold the assets and returned the proceeds and profits to the investors in a 3-5 year timeframe. These things may never return, but are a sign something always does.
The difference this time around, however, is that the breadth of the liquidity is wider. Private markets are a far more democratic place. Whereas in the past, the market was marked by bankers at the pointy end of the triangle, there’s now newer groups able to have a say.
Towards the wider end of that triangle are early stage and seed investors such as high net worth angel investors, friends and family, dedicated funds and the crowd funding world. That’s a significant number of folk who, we know from conversations we have every day at Asset Match, would appreciate the ability to reassess and rebalance their portfolios. At Asset Match, we frequently see dated investments, estate and ‘probate’ sales and they’re glad to find us. As we’ve pointed out before, there are a number of ambitious routes available to unlock trapped cash. E.g. the £1.7 trillion of assets held by occupational direct-benefit (DB) pension schemes. If you allowed just 5% of those assets to be liquidated by their shareholders, you would open up almost double the £50bn target in the Mansion House speech. Some gentle changes to the Companies Act and maybe Articles of Association could facilitate regular bouts of liquidity that benefit a company’s shareholders.
Regular liquidity events can contribute significantly to a much needed dam burst, supplementing the moves at the top. Through companies such as ours, the pointy end of the triangle no longer gets to dictate macro liquidity from an ivory tower.
Unfortunately, other routes to driving small company liquidity aren’t up to scratch. The options are primarily the bulletin board style marketplaces which simply announce a set price, or sub-markets such as AIM, which offers illusory value and charges companies a series of costs not justified by the service they get as well as an abject lack of liquidity.
Periodic auctions, though less frequent, can prevent market stagnation while also providing legitimate price discovery driven by market forces measured over time. They provide a time and place that corrals people into the liquidity process and a chance for interactions with buyers to determine a price. They can facilitate much needed ‘mark to reality’ liquidity, a welcome antidote to poor ‘mark to market’ liquidity and a new tool to remove the log from the liquidity log jam.